Jeanne Asseraf Bitton

Jeanne Asseraf Bitton

Head of Market Research

Lyxor Asset Management


Xavier Denis

Xavier Denis

Head of Cross Asset Research

Lyxor Asset Management


Choppy waters

09 Jul 2018

Active Strategies

 

Macro & Market Views

Global growth remains well sustained and the business cycle is set to extend further. However, headwinds are firming up with growing political risks and tighter USD liquidity, a challenge to stretched valuations on many markets. On the political front, trade tensions and European woes with Italian politics and Brexit are unlikely to derail growth, but are set to further weigh on business sentiment.

A full-blown trade war should be averted but tensions may linger until midterm elections in the U.S. In Europe, populism is back that could foster choppy waters for European financial markets. It has already weakened the single currency that should trade range bound market versus the U.S. dollar in the coming months. Decoupling is unfolding between the U.S. reacceleration and easing momentum elsewhere. The massive tax cuts are kicking in, boosting capex, hiring and consumption and share buybacks. As the U.S. economy is running above potential, the sharp drop in unemployment rate paves the way for an acceleration of wage inflation. This could eat in corporate margins should labor productivity growth fall behind.

We keep a mild preference on risky assets as we expect continued outperformance of equities versus bonds. There is a tug of war on equity markets. On one side, strong top line sales and robust earnings growth in the U.S. are supporting high valuations, on the other side, tighter liquidity, rising bond yields and politics are hurdles. Beside the U.S., a combination of softening growth and sluggish inflation cap long term bond yields but also expected performance on equities. Among equity markets, we have a tilt towards U.S. equities as earnings growth and momentum look stronger.

The Federal Reserve (“the Fed”) remains committed to monetary policy tightening. Inflation surprise would entail the risk of faster tightening than forecast, so bond markets may suffer even more warranting an underweight positioning on most fixed income assets. However, we are keen on holding onto spread products in the EU and U.S. inflation breakeven where we still see value.

We have downgraded to neutral on EM equities and we are underweight on EM debt (hard currencies). Stronger USD, tighter USD liquidity and rising oil prices are headwinds to the overall asset class. China could receive some modest overweight given its closed capital account and solid expansion despite some growth deceleration. Amid a steady rise in demand, supply is the main driver for oil prices. Less supply disruption in traditional oil and a step up of shale oil output edge price down marginally. Gold is struggling in a rising U.S. rate environment, but remains a compelling safe haven in the event of market turmoil.

Alternative Strategies

Markets are transitioning from goldilocks to late cycle. We still favor equities over bonds, but risks are building up at a time when the macro momentum is peaking, monetary normalization is accelerating and concerns about protectionism are increasing.

The coming quarter is likely to offer bumpier and modest beta contribution to hedge fund performance. Meanwhile, constraints on alpha have eased, probably due to higher dispersion in stock returns. While the coming quarter will probably remain difficult to navigate, hedge funds appear attractive relative to traditional asset classes.

We are positioned around three key axes: i) favor stock/bond selection strategies, ii) leverage the global M&A upswing, iii) favor strategies that benefit from rising bond yields.

We maintain an Overweight (OW) stance on Event-Driven and Merger Arbitrage, in particular. The latter is a strategy with low correlation to equities and low volatility in returns. Strong M&A volumes and reasonably high deal spreads should prove supportive. Special Situation funds are attractive as they leverage buoyant corporate activity; however, their long bias is a headwind. We also maintain an OW stance on Fixed Income Arbitrage, which has been a good diversifier in a context of rising bond yields. We are selective in the L/S Equity space, overall at Neutral (N), and prefer variable biased strategies (OW) to long biased (UW) ones. We remain defensive on market neutral strategies (N), which are sensitive to factor rotations.

The environment is less supportive for Macro / CTAs in relative terms. We maintain CTAs at (N) and prefer midterm to long term CTAs in a constrained trend following environment. We are also defensive on Global Macro (N), especially on EM-focused funds (UW) while we prefer diversified strategies (N).


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